Cotton Market Update for the Week Ending Thursday October 19, 2018

The week ending Friday October 19 saw ICE cotton futures start off sideways, and then erode to a lower sideways pattern by week’s end.  This was in defiance of many expectations of a market rally following preliminary estimates of 500,000 to 1,000,000 bales lost in the Southeast.  Although the aggregate losses will doubtless be substantial, the market may be waiting on slower assessment processes from USDA and private crop insurance adjusters.  At any rate, a strong futures market reaction may take some time.  Other evidence of this is that hedge fund net longs actually cut their position by almost 6,000 contracts between October 9 and October 16.  Other fundamental cotton market influences this week included more rainfall across Texas and the Mid-South, and another weak export sales report to soften a longstanding bullish picture of export commitments.

The Dec’18 contract settled on Friday at 77.92 cents per pound.  The Jul’19 contract settled the week at 81.23, while the distant Dec’19 settled Friday at 76.68 cents per pound.  Chinese and world cotton prices were both mixed this week.

A sample of option premiums on ICE cotton futures saw changes from prior weeks due to slight declines in the the underlying futures, as well as time value erosion.  On Thursday, October 18, a deep in-the-money 90 cent put option on Dec’18 cotton was worth 11.99 cents per pound. An 85 put settled Thursday at 7.08 cents per pound while an 80 put settled at 2.67 cents per pound. These values and their change over the last month show how put options increase in value with falling futures prices, thus acting as down-side price insurance.  They also show how the time value is exponentially eroding for a soon-expiring option.  An out-of-the-money 85 call on Jul’19 cotton was worth 3.06 cents per pound.  Looking way out there, a near-the-money 75 put on Dec’19 cotton settled Thursday at 3.73 cents per pound.

This week provides another example of the ever present risk of unexpected market volatility.  It can happen in both directions.  For example, a surprise resolution to U.S.-China trade relations, confirmation of extensive hurricane damage, or something else totally unexpected could trigger speculative buying.  As always, the most relevant question is whether a cash contract or a hedge on today’s futures price will be a profitable, or at least survivable, price floor.

Given all these uncertainties, growers should always be poised and ready to take advantage of rallies, and protect themselves from sudden sell-offs. Forward contracting of new crop bales, immediate post-harvest contracting of old crop bales, and/or various options strategies can be used to limit downside risk while retaining upside potential.   Earlier hedges with puts or put spreads on Dec’18 futures should be evaluated with an eye towards exiting those positions this month.  With the recent decline in the futures market, put strategies have been accruing value.  Contracted 2018 bales could be combined with call options on the deferred futures contracts.  Call option strategies have become increasingly affordable with the recent decline in the futures market. New crop put strategies to hedge the 2019 crop are a straightforward and relevant approach.